Chapter 11 — Troubled Debt Restructurings

11.4 Accounting for a TDR

11.4.1 General

11.4.1.1 Background

ASC 470-60

10-1 The accounting for restructured debt is based on the substance of the modifications — the effect on cash flows — not on the labels chosen to describe those cash flows. The substance of all modifications of a debt in a troubled debt restructuring is essentially the same whether they involve modifications of any of the following:

Timing
Amounts designated as interest
Amounts designated as face amounts.

10-2 All of those kinds of modifications affect future cash receipts or payments and therefore affect both of the following:

The creditor’s total return on the receivable, its effective interest rate, or both
The debtor’s total cost on the payable, its effective interest rate, or both.

35-1 A debtor shall account for a troubled debt restructuring according to the type of the restructuring as prescribed in this Section.

The accounting for a TDR depends on whether it involves a transfer of assets, the grant of an equity interest, a modification of the debt terms, or a combination thereof:

Transfer of assets (see Sections 11.4.2 and 11.4.5) — The debtor transfers trade receivables, real estate, or other assets to the creditor to fully or partially satisfy outstanding debt.
Grant of equity interest (see Sections 11.4.3 and 11.4.5) — The debtor issues an equity interest (e.g., the issuer’s common or preferred stock) to the creditor to fully or partially satisfy outstanding debt.
Modification of the debt terms (see Section 11.4.4) — For example:
- A reduction of the stated interest rate.
- A reduction of the principal amount of the debt.
- An extension of maturity dates.
- A forgiveness or reduction of the amount of accrued interest due.
- A payment deferral.

If a TDR involves a transfer of assets, any difference between the fair value (under ASC 820) and carrying amount of the transferred assets at the time of the restructuring is reflected as a gain or loss in the same manner as if the assets were sold for cash. If a TDR involves a grant of an equity interest, the equity securities are initially recognized at fair value in accordance with ASC 820 at the time of the restructuring. However, if a TDR involves a modification of debt terms, it is accounted for only prospectively unless the carrying amount exceeds the undiscounted total amount of future cash payments.

11.4.1.2 Unit of Account

ASC 470-60

15-4 The substance rather than the form of the payable shall govern. . . . Typically, each payable is negotiated separately, but sometimes two or more payables are negotiated together. For example, a debtor may negotiate with a group of creditors but sign separate debt instruments with each creditor. For purposes of this Subtopic, restructuring of each payable, including those negotiated and restructured jointly, shall be accounted for individually.

55-3 To a debtor, a bond constitutes one payable even though there are many bondholders.

If an entity determines that a debt restructuring should be accounted for as a TDR, it applies the TDR accounting requirements in ASC 470-60 separately to each unit of account (see Section 3.3). This means that the TDR must be accounted for on a creditor-by-creditor basis. However, if one creditor (or multiple creditors with a consolidated group or otherwise under common control) holds multiple debt instruments before or after the restructuring, the debtor should determine whether a restructuring gain may be recognized by considering the aggregate relationship with such creditor. If, as a result of the relationship with the individual creditor, one debt instrument is restructured into multiple debt instruments, or multiple debt instruments are restructured into one debt instrument, the debtor will need to allocate the existing carrying amount of the original debt instrument (or aggregate carrying amount of the original debt instruments) to the restructured debt instrument or instruments. Performing this allocation may require judgment. Subsequently, each debt instrument that meets the definition of a freestanding financial instrument should be accounted for as a separate unit of account.

Example 11-7

Debt Owned by Multiple Creditors

Entity G has subordinated debentures that are held by a significant shareholder, a major insurance company, and other parties. Entity G is experiencing financial difficulties and has negotiated with the shareholder and the major insurance company to redeem the debentures for senior indebtedness and a combination of preferred and common stock of G. In addition, G has offered the other parties a package of preferred stock and cash in exchange for their subordinated debentures.

The TDR accounting requirements of ASC 470-60 should be applied to each individual transaction (or group of creditors) rather than in the aggregate because each group separately negotiated its restructuring. In substance, there are three creditor groups. If a company presents a restructuring plan to holders of debt securities and a portion of the debt holders accept the plan, the company should account for the bonds as TDRs to the extent of the participation in the exchange offer. Accordingly, the TDR accounting requirements of ASC 470-60 should be applied only to the portion of the bonds that are actually restructured. The accounting for the bonds owned by bondholders that do not participate in the restructuring is not affected.

11.4.1.3 Time of Restructuring

ASC Master Glossary

Time of Restructuring

Troubled debt restructurings may occur before, at, or after the stated maturity of debt, and time may elapse between the agreement, court order, and so forth, and the transfer of assets or equity interest, the effective date of new terms, or the occurrence of another event that constitutes consummation of the restructuring. The date of consummation is the time of the restructuring.

A TDR should be recognized in the period in which it occurs (i.e., at the time of the debt restructuring). The time of the restructuring is the date of its consummation (e.g., the date on which any assets or equity interests are transferred in settlement of the debt, or new debt terms become legally binding). A debtor should not recognize a gain on restructuring before consummation of the restructuring.

If an entity restructures debt after its balance sheet date but before issuing its financial statements, that restructuring is a nonrecognized subsequent event under ASC 855. However, the debtor is required to consider whether the restructuring is of such a nature that it must be disclosed to keep the financial statements from being misleading (see ASC 855-10-50-2).

Example 11-8

Debt Modification That Is Consummated After the Balance Sheet Date

Entity H has $120 million of notes outstanding. On October 31, 20X1, H defaulted on an interest payment due under the debt and entered into negotiations with the noteholders to restructure the debt. On December 1, 20X1, the noteholders agreed to exchange their existing notes for new notes through an exchange offer to be completed before February 28, 20X2. The noteholders had a choice of receiving new notes or a combination of new notes and cash. The agreement stipulated certain steps that H was to take before the exchange offer could take place (e.g., renewal of a line of credit, sale of a division for cash). On December 31, 20X1, no legal documentation had been finalized for the restructuring; the agreement was therefore not binding. On February 8, 20X2, the choices of all noteholders had been received and the exchange offer document was finalized.

Because the actual debt restructuring occurred after December 31, 20X1, and was not legally binding on December 31, 20X1, the transaction should be treated as a nonrecognized subsequent event and recognized in the first quarter of 20X2. Accordingly, interest should be accrued as of December 31, 20X1, on the basis of the terms of the original debt agreements.

11.4.1.4 Costs and Fees

ASC 470-60

35-12 Legal fees and other direct costs that a debtor incurs in granting an equity interest to a creditor in a troubled debt restructuring shall reduce the amount otherwise recorded for that equity interest according to paragraphs 470-60-35-4 and 470-60-35-8. All other direct costs that a debtor incurs to effect a troubled debt restructuring shall be deducted in measuring gain on restructuring of payables or shall be included in expense for the period if no gain on restructuring is recognized.

The accounting for any costs and fees incurred in connection with a TDR depends on whether they are attributable to an equity interest granted. Legal fees and other direct costs of issuing an equity interest (e.g., common or preferred stock) reduce the initial carrying amount of the equity interest issued. Other costs incurred in a TDR (e.g., a TDR that involves the transfer of assets or a debt modification or exchange) reduce any restructuring gain recognized (see Section 11.4.4) or, if there is no gain, are expensed in the period incurred. If the TDR represents a combination of the characteristics in ASC 470-60-15-9(a)–(c), a debtor should use a reasonable method to allocate fees and costs between equity interests granted and the restructuring gain or expenses (e.g., by specifically identifying such costs). Costs incurred related to a potential restructuring that has not been completed as of the balance sheet date may not be deferred and recognized as an asset.

ASC 470-60-35-12 does not apply to any remaining unamortized debt issuance costs at the time of the restructuring; such costs are part of the debt’s carrying amount immediately before the restructuring. Accordingly, if the total amount of future undiscounted cash flows of the restructured debt exceeds the carrying amount, such costs continue to be amortized after the TDR (see Section 11.4.4.2). Alternatively, if the TDR involves the recognition of a restructuring gain, any remaining unamortized debt issuance costs reduce the amount of the gain that would otherwise have been recognized (see Section 11.4.4.3).

11.4.1.5 Related-Party Transactions

ASC 470-60 applies to all debt restructurings (i.e., there is no scope exception for transactions with related parties). However, if the creditor is a related party (e.g., a significant shareholder), any restructuring gain would be recognized in equity in accordance with ASC 470-50-40-2 (see Section 9.3.7.2). Since the evaluation of whether the creditor is a related party of the debtor under ASC 850 is performed immediately before the restructuring, any equity interests granted as part of the restructuring would not affect the determination of whether a restructuring gain should be recognized as a capital contribution.

Example 11-9

TDR Involving a Related Party

To meet future needs for debt service, operations support, and capital outlay, Entity J negotiated a restructuring with its preferred stockholders, subordinated debt holders, and bank debt holders. As part of the restructuring, the aggregated outstanding principal amount of the subordinated debt was converted into shares of common stock. The value provided to the debt holders in the form of the common stock was substantially less than the carrying amount of the subordinated debt before the exchange. The subordinated debt holders also had significant investments in preferred stock of J.

By analogy to ASC 470-50-40-2 (see Section 9.3.7.2), forgiveness of the amounts owed to a significant shareholder should be accounted for as a capital contribution to the debtor to the extent that the carrying amount of the payable on the date of the restructuring exceeds either (1) the total future cash payments that will be made to the shareholder under the new terms or (2) the fair value of the assets transferred or the equity interest granted. Accordingly, J should recognize the “restructuring gain” realized from the forgiveness of amounts owed as an equity capital contribution.

11.4.2 Accounting for Transfer of Assets in Full Settlement of Troubled Debt

ASC 470-60

35-2 A debtor that transfers its receivables from third parties, real estate, or other assets to a creditor to settle fully a payable shall recognize a gain on restructuring of payables. The gain shall be measured by the excess of the carrying amount of the payable over the fair value of the assets transferred to the creditor. However, while the guidance in this Subtopic indicates that the fair value of assets transferred or the fair value of an equity interest granted shall be used in accounting for a settlement of a payable in a troubled debt restructuring, that guidance is not intended to preclude using the fair value of the payable settled if more clearly evident than the fair value of the assets transferred or of the equity interest granted in a full settlement of a payable. However, in a partial settlement of a payable, the fair value of the assets transferred or of the equity interest granted shall be used in all cases to avoid the need to allocate the fair value of the payable between the part settled and the part still outstanding.

35-3 A difference between the fair value and the carrying amount of assets transferred to a creditor to settle a payable is a gain or loss on transfer of assets. The carrying amount of a receivable encompasses not only unamortized premium, discount, acquisition costs, and the like but also an allowance for uncollectible amounts and other valuation accounts, if any. The debtor shall include that gain or loss in measuring net income for the period of transfer, reported as provided in Topic 220. A loss on transferring receivables to creditors may therefore have been wholly or partially recognized in measuring net income before the transfer and be wholly or partly a reduction of a valuation account rather than a gain or loss in measuring net income for the period of the transfer.

If a debtor pays cash to settle troubled debt in full, it recognizes a restructuring gain to the extent that the carrying amount exceeds the amount of cash paid. ASC 470-60 requires a debtor to apply a “two-step” approach in accounting for a TDR involving a transfer of noncash assets (including a repossession or foreclosure of assets; see Section 11.2.2). That is, when a debtor transfers a noncash asset in full settlement of a debt, any resulting gain or loss consists of two separate components:

The difference, if any, between the fair value and carrying amount of the asset transferred is recognized as a gain or loss upon derecognition of the asset transferred. (If an issuer transfers assets in full settlement of a payable, ASC 470-60-35-2 does not preclude the debtor from calculating this gain or loss on the basis of the fair value of the payable settled instead of the fair value of the assets transferred if the fair value of the payable settled is more clearly evident.)
The difference, if any, between that fair value and the carrying amount of the debt is recognized as a restructuring gain on the debt that is settled.

A “one-step” approach is not appropriate. Under such a method, a restructuring gain or loss would be recognized for the net difference between the carrying amount of the asset transferred and the carrying amount of the payable settled.

For TDRs that occurred during a reporting period, ASC 470-60-50-1 requires separate disclosure, either on the face of the financial statements or in the accompanying notes, of (1) the aggregate net gain or loss on asset transfers recognized during the period and (2) the aggregate gain on restructuring of payables (see Section 11.5.2).

Example 11-10

Accounting for a Transfer of Financial Assets in Full Settlement of a Payable

Entity K is experiencing financial difficulties and agrees to settle its $125 million of debt to Creditor C in full by transferring fixed-rate loan receivables that have a carrying amount of $130 million. Entity K estimates the current fair value of the receivables to be $110 million.

Even though the carrying amount of the assets transferred exceeds the carrying amount of the debt settled, K would recognize a restructuring gain of $15 million to reflect the difference between the fair value of the assets transferred to settle the debt and the carrying amount of the debt settled. Further, it would recognize a loss on the asset transfer of $20 million.

Example 11-11

Accounting for a Transfer of Nonfinancial Assets in Full Settlement of a Payable

Entity L is experiencing financial difficulties and will not be able to make the scheduled payments on its outstanding note to Entity T. Entity L has reached an agreement with T under which L will transfer land to T to fully settle the outstanding obligation. The land has a book value of $90,000 and a fair value of $100,000. The outstanding note has a principal balance of $100,000 and related accrued interest of $5,000. Entity L would record the following entry related to the settlement:

Example 11-12

Accounting for a Foreclosure of Collateral in Full Settlement of a Payable

Entity M, whose fiscal year ends on December 31, owns a mall that is subject to nonrecourse debt. The fair value of the mall is significantly less than the amount of related debt (due November 1, 20X4) and the carrying amount of the mall. Although M is currently negotiating with the lender, M believes that it will most likely allow the bank to foreclose on the property, in which case it will realize a gain on extinguishment of debt. Consequently, M believes that it will not be able to recover the carrying amount of the asset and that it should therefore recognize a loss on impairment. Entity M would prefer not to record an impairment loss on the property in its third quarter but rather recognize a gain on extinguishment of debt in its fourth quarter.

Entity M cannot defer recognition of the impairment loss until its fourth quarter and net the loss with the anticipated gain on the extinguishment of debt. ASC 360-10-35-15 through 35-49 require an entity to measure an impairment loss for a long-lived asset, including an asset that is subject to nonrecourse debt, as the amount by which the carrying amount of the asset (asset group) exceeds its fair value. The recognition of an impairment loss and the recognition of a gain on the extinguishment of debt are separate events, and each event should be recognized in the period in which it occurs. The recognition of an impairment loss should be based on the measurement of the asset at its fair value; the existence of nonrecourse debt should not influence that measurement.

11.4.3 Accounting for Grant of Equity Interest in Full Settlement of Troubled Debt

ASC 470-60

35-4 A debtor that issues or otherwise grants an equity interest to a creditor to settle fully a payable shall account for the equity interest at its fair value. The difference between the fair value of the equity interest granted and the carrying amount of the payable settled shall be recognized as a gain on restructuring of payables.

When a debtor grants an equity interest (e.g., common or preferred stock or warrants that qualify for classification in equity) in full settlement of debt in a TDR, multiple financial statement accounts are affected:

The debtor recognizes an increase in shareholders’ equity for the fair value of the equity interests issued less legal fees and other direct issuance costs (see Section 11.4.1.4). (If an issuer grants equity interests in full settlement of a payable, it is permitted to elect to measure the equity interests issued on the basis of the fair value of the payable settled instead of the fair value of the equity interests issued if the fair value of the payable settled is more clearly evident; see ASC 470-60-35-2.)
The difference, if any, between that fair value and the carrying amount of the debt is recognized as a restructuring gain on the debt that is settled.

The FASB has rejected approaches that would have involved including the restructuring gain in equity or increasing equity for the carrying amount of the payable settled with no gain recognized.

Example 11-13

Accounting for a Transfer of Equity Shares in Full Settlement of a Payable

Entity N is experiencing financial difficulties. It agrees with creditors to settle outstanding nonconvertible debt with a carrying amount of $45 million in full by issuing 10 million shares of common stock, which have an aggregate fair value of $25 million at the time of the restructuring (i.e., $2.50 per share). Accordingly, N recognizes a restructuring gain of $20 million.

If a debtor issues a mandatorily redeemable financial instrument in the form of a share that must be classified as a liability under ASC 480-10-25-4, the issuer should not account for it as a grant of an equity interest under ASC 470-60 but as a troubled debt modification or exchange (see Section 11.4.4).

Example 11-14

Accounting for a Transfer of Liability-Classified Shares in Full Settlement of a Payable

Entity O has restructured its debt because of its inability to service its existing debt load. As part of the restructuring, O’s creditor exchanged O’s debt for a new note and shares of mandatorily redeemable preferred stock classified as a liability under ASC 480-10-25-4.

The issuance of liability-classified mandatorily redeemable preferred stock should not be viewed as the granting of an equity interest under ASC 470-60-35-4 or ASC 470-60-35-8. The substance of the exchange of liability-classified mandatorily redeemable equity securities for debt represents a continuation of monetary payments under new terms. Therefore, such a transaction should be accounted for as a modification of the debt terms in accordance with ASC 470-60-35-5 through 35-7. A gain would be recognized only to the extent that the carrying amount of the existing debt exceeds all future payments (including dividends and contingent dividends) to be made on the new note and redeemable equity securities.

By contrast, if O had issued a new note and redeemable preferred stock that qualified for equity classification under ASC 480 (e.g., mandatorily redeemable preferred stock that is convertible into common stock or nonmandatorily redeemable preferred stock), the transaction would be accounted for as a partial settlement in accordance with paragraph ASC 470-60-35-8.

11.4.4 Accounting for a Troubled Debt Modification or Exchange

11.4.4.1 Background

If a modification of debt terms qualifies as a TDR, the debtor accounts for the effect of the modification to the debt terms prospectively as an adjustment to the effective interest rate except that the rate cannot be reduced below zero. Although a TDR involves a concession, the debtor does not recognize a restructuring gain (or corresponding adjustment to the carrying amount) unless the carrying amount exceeds the total undiscounted future principal and interest payments of the restructured debt.

Accordingly, as of the time of the restructuring, the debtor should compare the total amount of undiscounted future cash payments required by the modified terms (excluding contingently payable amounts) with the debt’s carrying amount. Different considerations are necessary if the future cash payments exceed the debt’s carrying amount (see Section 11.4.4.2) or if the debt’s carrying amount exceeds the future cash payments (see Section 11.4.4.3). Other special considerations are necessary related to restructured debt with contingent payments (see Section 11.4.4.4); put, call, or prepayment features (see Section 11.4.4.5); and variable-rate debt (see Section 11.4.4.6). Section 11.4.4.7 compares the accounting for a troubled debt modification or exchange with that for a nontroubled debt modification or exchange.

Since a TDR involves a concession made by the creditor, a TDR typically cannot result in the recognition of a restructuring loss by the debtor.

11.4.4.2 Future Cash Payments Exceed Carrying Amount

ASC 470-60

35-5 A debtor in a troubled debt restructuring involving only modification of terms of a payable — that is, not involving a transfer of assets or grant of an equity interest — shall account for the effects of the restructuring prospectively from the time of restructuring, and shall not change the carrying amount of the payable at the time of the restructuring unless the carrying amount exceeds the total future cash payments specified by the new terms. Total future cash payments includes related accrued interest, if any, at the time of the restructuring that continues to be payable under the new terms. That is, the effects of changes in the amounts or timing (or both) of future cash payments designated as either interest or face amount shall be reflected in future periods. Interest expense shall be computed in a way such that a constant effective interest rate is applied to the carrying amount of the payable at the beginning of each period between restructuring and maturity (in substance the interest method prescribed by paragraphs 835-30-35-2 and 835-30-35-4 through 35-5). The new effective interest rate shall be the discount rate that equates the present value of the future cash payments specified by the new terms (excluding amounts contingently payable) with the carrying amount of the payable.

If the total amount of future undiscounted cash payments required by the modified terms (excluding contingently payable amounts) exceeds the debt’s carrying amount, a restructuring gain is not recognized and the effective interest rate is adjusted to reflect the modified terms. The adjusted effective interest rate is the discount rate that equates the future cash payments required by the modified agreement, excluding amounts contingently payable, with the debt’s carrying amount at the time of the restructuring. After the TDR, interest expense is recognized by using the adjusted effective interest rate.

Example 11-15

Accounting for an Extension of the Maturity Date of a Payable

Entity P has an outstanding note payable that will yield total interest of $4 million. The note matures on September 30, 20X3, on which date the creditor becomes fully entitled to payment of all principal and interest. Entity P is experiencing financial difficulties and will be unable to make the scheduled principal and interest payments on the original due date.

On September 1, 20X3, P negotiated an extension of the maturity date to December 31, 20X3. The extension has not changed the amount of principal or interest to be paid by P. The creditor agreed to extend the maturity date to increase its ability to recover its investment. As of September 1, 20X3, $3.5 million had been accrued by P as interest expense.

The extension of the maturity date represents a TDR (see ASC 470-60-15-9(c)(2)). Since the creditor did not obtain any additional entitlement to principal or interest in exchange for the extension, P effectively extended the maturity of its debt at a zero percent interest rate. Entity P’s remaining unrecognized interest expense ($500,000) on September 1, 20X3, should be accrued by P over the remaining maturity in accordance with ASC 470-60-35-5 (i.e., constant effective interest rate) so that the full amount of interest expense of $4 million will be recognized by December 31, 20X3.

Example 11-16

Accounting for a Reduction in the Interest Rate on a Payable

As of January 1, 20X1, Entity Q has a note payable to Entity S with a principal balance of $95,000, accrued interest of $5,000, an interest rate of 5 percent, and a remaining life of five years. Interest is payable on December 31 each year. Because of Q’s financial difficulties, S has agreed to forgive all of the accrued interest and lower the stated interest rate to 4 percent.

In this example, the future cash payments exceed the carrying value of the liability (see calculation below). Therefore, in accordance with ASC 470-60-35-5, the carrying amount of the note is not adjusted.

The effects of changes in the amount and timing of future cash payments should be accounted for prospectively. A new effective interest rate should be calculated so that the present value of the future payments equals the carrying amount of the liability ($100,000).

Interest Amortization Schedule

The following entries would be recorded by the debtor to reflect the terms of the modified agreement (note that no entry is required on January 1, 20X1 — the date of the modification):

Example 11-17

Accounting for a Reduction in the Interest Rate on a Payable

On December 31, 20X0, Entity R issues five-year debt for net proceeds of $260,000. The principal amount is $250,000, and the stated interest rate is 5.50 percent payable annually in arrears. Because the debt was issued at net premium, its stated interest rate differs from its effective interest rate. By solving for the rate that equates the initial net proceeds to the future contractual interest and principal cash flows, R determines that the annual effective interest rate is 4.59 percent (see Section 6.2). The full discount amortization schedule is shown below.

Entity R is experiencing financial difficulties and negotiates a debt restructuring with the debt holder. On January 1, 20X3, the holder agrees to reduce the stated coupon rate to 2 percent.

In evaluating whether the holder has granted a concession, R calculates the effective borrowing rate of the restructured debt (see Section 11.3.3.4.1). Entity R solves for the discount rate that equates the future cash flows of the modified debt to the current carrying amount of the original debt ($256,266.79) and determines that the revised annual effective borrowing rate is 1.15 percent. Because the original effective borrowing rate exceeds the revised effective borrowing rate, the holder has granted a concession. Since R is experiencing financial difficulties, the debt restructuring qualifies as a TDR.

The sum of the undiscounted future contractual interest and principal cash flows ($265,000) exceeds the current carrying amount of the debt ($256,266.79). Therefore, R does not recognize a restructuring gain; instead, it adjusts the effective interest rate to reflect the modified cash flows.

The revised amortization schedule is shown below.

11.4.4.3 Carrying Amount Exceeds Future Cash Payments

ASC 470-60

35-6 If, however, the total future cash payments specified by the new terms of a payable, including both payments designated as interest and those designated as face amount, are less than the carrying amount of the payable, the debtor shall reduce the carrying amount to an amount equal to the total future cash payments specified by the new terms and shall recognize a gain on restructuring of payables equal to the amount of the reduction. If the carrying amount of the payable comprises several accounts (for example, face amount, accrued interest, and unamortized premium, discount, finance charges, and issue costs) that are to be continued after the restructuring, some possibly being combined, the reduction in carrying amount may need to be allocated among the remaining accounts in proportion to the previous balances. Thereafter, all cash payments under the terms of the payable shall be accounted for as reductions of the carrying amount of the payable, and no interest expense shall be recognized on the payable for any period between the restructuring and maturity of the payable. The only exception is to recognize interest expense according to paragraph 470-60-35-10. However, the debtor may choose to carry the amount designated as face amount by the new terms in a separate account and adjust another account accordingly.

If the debt’s carrying amount exceeds the total amount of future undiscounted cash payments required by the modified terms (excluding contingently payable amounts), the effective interest rate is reset to zero. Thereafter, the debtor accounts for any cash paid (including amounts designated as interest) as a reduction of the carrying amount and no interest expense is recognized. As of the time of the restructuring, the debtor should also evaluate whether the modified terms specify any contingently payable or otherwise currently indeterminate amounts (e.g., additional amounts become payable if the debtor’s financial situation improves or the stated interest rate is indexed to a market interest rate).

If the modified terms do not specify any contingently payable or otherwise currently indeterminate amounts, the debtor recognizes a debt restructuring gain at the time of the restructuring equal to the excess of the debt’s carrying amount over the total amount of undiscounted future cash payments. However, if the modified terms do specify such amounts, the debtor recognizes a debt restructuring gain only if the debt’s carrying amount exceeds the maximum potential amount of total undiscounted future cash payments that the debtor might be required to pay (irrespective of the likelihood that the debtor would be required to pay them; see Section 11.4.4.4).

Example 11-18

Calculation of Gain on Modification Involving Forgiveness of Principal and Accrued Interest and a Reduction of the Interest Rate on a Payable

As of January 1, 20X1, Entity S has a note payable to Entity X with a principal balance of $100,000, accrued interest of $10,000, an interest rate of 5 percent, and a remaining life of five years. Because of S’s financial difficulties, S agrees to modify the note by reducing the principal amount to $80,000, lowering the stated interest rate to 4 percent, and forgiving all accrued interest. Interest is payable on December 31 each year.

In this example, the future cash payments are less than the carrying value of the liability (see calculation below). Therefore, in accordance with ASC 470-60-35-6, the carrying value of the note should be adjusted. Furthermore, all future cash payments under the terms of the modified agreement should reduce the carrying amount of the note. No interest expense should be recognized on the note payable between the restructuring and the maturity of the note.

The calculation of the S’s gain on restructuring is as follows:

Example 11-19

Calculation of Gain on Modification Involving a Forgiveness of Principal and a Reduction of the Interest Rate on a Payable

On December 31, 20X0, Entity T issues five-year debt for net proceeds of $120,000. The principal amount is $125,000, and the stated interest rate is 6 percent payable annually in arrears. Because the debt was issued at a net discount, its stated interest rate differs from its effective interest rate. By solving for the rate that equates the initial net proceeds to the future contractual interest and principal cash flows, T determines that the annual effective interest rate is 6.97 percent (see Section 6.2). The full discount amortization schedule is shown below.

Entity T is experiencing financial difficulties and negotiates a debt restructuring with the debt holder. On January 1, 20X3, the holder agrees to forgive $15,000 of principal and to reduce the stated interest rate to 2 percent. There are no contingently payable or otherwise currently indeterminate amounts payable on the restructured debt.

In evaluating whether the holder has granted a concession, T calculates the effective borrowing rate of the restructured debt (see Section 11.3.3.4.1). Entity T solves for the discount rate that equates the future cash flows of the modified debt to the current carrying amount of the original debt ($121,800.45) and determines that the revised annual effective borrowing rate is negative. Because the original effective borrowing rate exceeds the revised effective borrowing rate, the holder is deemed to have granted a concession. Since T is experiencing financial difficulties, the debt restructuring qualifies as a TDR.

The sum of the undiscounted future contractual interest and principal cash flows ($116,600) is less than the current carrying amount of the debt ($121,800.45). Further, there are no contingently payable or otherwise indeterminate amounts. Therefore, T recognizes a restructuring gain for the amount by which the current carrying amount exceeds the total amount of undiscounted future cash payments; that is, it recognizes a gain of $5,200.45. Further, T adjusts the effective interest rate to zero. The revised amortization schedule is shown below.

11.4.4.4 Contingent Payment Terms

11.4.4.4.1 Limit on the Recognition of Restructuring Gains

ASC 470-60

35-7 A debtor shall not recognize a gain on a restructured payable involving indeterminate future cash payments as long as the maximum total future cash payments may exceed the carrying amount of the payable. Amounts designated either as interest or as face amount by the new terms may be payable contingent on a specified event or circumstance (for example, the debtor may be required to pay specified amounts if its financial condition improves to a specified degree within a specified period). To determine whether the debtor shall recognize a gain according to the provisions of the preceding two paragraphs, those contingent amounts shall be included in the total future cash payments specified by the new terms to the extent necessary to prevent recognizing a gain at the time of restructuring that may be offset by future interest expense. Thus, the debtor shall apply paragraphs 450-30-25-1 and 450-30-50-1 in which probability of occurrence of a gain contingency is not a factor, and shall assume that contingent future payments will have to be paid. The same principle applies to amounts of future cash payments that must sometimes be estimated to apply the provisions of the preceding two paragraphs. For example, if the number of future interest payments is flexible because the face amount and accrued interest is payable on demand or becomes payable on demand, estimates of total future cash payments shall be based on the maximum number of periods possible under the restructured terms.

Sometimes, the terms of restructured debt specify contingently payable amounts. For example, the debtor might be required to pay additional amounts of principal or interest if its financial condition or financial performance improves. To prevent offsetting by future interest expense, ASC 470-60 precludes the recognition of a restructuring gain if the restructured debt specifies contingent payments and the maximum total possible amount of contingent and noncontingent payments equals or exceeds the carrying amount of the debt. The likelihood that contingent payments might need to be paid is not a factor. In determining the amount of any restructuring gain, the debtor must assume that it will have to pay the maximum amount possible under any contingent payment terms. Therefore, the debtor should reduce the amount of any restructuring gain that would otherwise have been recognized up to the maximum total undiscounted amount of any contingent payments.

As noted above, the purpose of the guidance is to prevent the debtor from recognizing a restructuring gain that might be offset by future losses under contingent payment terms. This means that the debtor should first compare (1) the debt’s carrying amount immediately before the modification with (2) the total amount of undiscounted future cash payments required by the modified debt terms (excluding contingently payable amounts):

If the total amount of undiscounted future cash payments (excluding contingently payable amounts) exceeds the carrying amount immediately before the debt restructuring, the debtor adjusts the effective interest rate prospectively to reflect the modified cash flows (see Section 11.4.4.2). In this circumstance, there is no restructuring gain, the carrying amount is not adjusted, and no portion of the carrying amount is attributable to contingently payable amounts at the time of the restructuring.
If the carrying amount immediately before the debt restructuring exceeds the amount of undiscounted future cash payments (excluding contingently payable amounts), the effective interest rate is reset to zero (see Section 11.4.4.3). Further, in this circumstance, the debtor should compare the carrying amount immediately before the modification with the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts):
- If the carrying amount immediately before the debt restructuring exceeds the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts), the debtor recognizes a debt restructuring gain and a corresponding decrease in the carrying amount for the difference at the time of the restructuring. In this circumstance, any or all contingently payable amounts are included in the carrying amount as if they were not contingent.
- If the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts) exceeds the carrying amount immediately before the debt restructuring, there is no restructuring gain and the carrying amount is not adjusted. In this circumstance, a portion of contingently payable amounts are included in the carrying amount at the time of the restructuring but only to the extent that they offset the contingent gain that would otherwise have been recognized.

Contingently payable amounts include cash as well as other contingently payable amounts (e.g., equity shares).

Example 11-20

Accounting for a Modification Involving Contingently Payable Amounts

Entity U has outstanding debt with a carrying amount of $1.5 million, an effective interest rate of 10 percent per annum, and a remaining term of eight years. On January 1, 20X1, U is experiencing financial difficulties and negotiates a debt restructuring with its creditor. Under the terms of the restructured debt, the creditor reduces the principal amount to $750,000 (i.e., it forgives $750,000). The stated rate of the restructured debt is 10 percent per annum payable annually in arrears. The maturity date is not modified. In conjunction with the modification, U agrees that if it is acquired by a third party at any time before the final maturity of the debt, it will make an additional payment to the creditor in an amount equal to the forgiven principal amount.

On the basis of the carrying amount and the modified cash flows, excluding the contingent payment that will be made if U is acquired, U determines that the undiscounted future cash flows of $1,350,000, or $750,000 + ($750,000 × .10 × 8) are less than the existing carrying amount of the debt (i.e., $1,500,000). Because U is experiencing financial difficulties and a concession has been granted, TDR accounting applies. The maximum total possible amount of principal and interest payments is $2.1 million. Consequently, there should be no change to the carrying amount of the debt and no interest expense recognized prospectively provided that an acquisition of U is not expected. Any remaining carrying amount of the debt at maturity would be recognized by U as a gain as long as an acquisition of A did not occur.

11.4.4.4.2 Subsequent Accounting

ASC 470-60

35-10 If a troubled debt restructuring involves amounts contingently payable, those contingent amounts shall be recognized as a payable and as interest expense in future periods in accordance with paragraph 450-20-25-2. Thus, in general, interest expense for contingent payments shall be recognized in each period in which both of the following conditions exist:

It is probable that a liability has been incurred.
The amount of that liability can be reasonably estimated.

Before recognizing a payable and interest expense for amounts contingently payable, however, accrual or payment of those amounts shall be deducted from the carrying amount of the restructured payable to the extent that contingent payments included in total future cash payments specified by the new terms prevented recognition of a gain at the time of restructuring (see paragraph 470-60-35-7).

The accounting for probable and actual losses under contingent payment terms after the debt restructuring depends on whether those losses were included in the carrying amount at the time of the restructuring. To the extent that potential losses under contingent payment terms prevented the recognition of a restructuring gain at the time of the restructuring (i.e., they are included in the debt’s carrying amount), the realization of such losses after the debt restructuring are accounted for as a direct reduction of the debt’s carrying amount (e.g., as debit to debt and a credit to cash). When the debt’s carrying amount includes an accrual for such losses at the time of the restructuring, it would be inappropriate to recognize an additional payable for the losses without a corresponding reduction in the carrying amount (i.e., the same losses would be counted twice).

The terms of restructured debt might specify that a contingent payment obligation expires if a specified event does not occur by a stated date before the debt matures. If the contingent payment obligation precluded the recognition of a restructuring gain on the date of the debt restructuring and the amount of the contingent payment obligation was therefore included in the carrying amount of the restructured debt, the expiration of the contingent payment obligation is accounted for as a partial extinguishment of the restructured debt (see Section 9.3). Special considerations apply to variable-rate debt (see Section 11.4.4.6).

Unless the contingent payment feature is bifurcated as a derivative instrument under ASC 815-15, the debtor should apply a loss contingency approach in a manner similar to that in ASC 450-20 to accrue for any estimated losses under contingent payment terms that exceed the amount of contingently payable amounts that were included in the carrying amount at the time of the restructuring. That is, the debtor would recognize interest expense with a corresponding increase to the carrying amount of the debt (or a separate payable) if such incremental losses are probable and can be reasonably estimated.

A debtor is required to disclose the extent to which inclusion of contingent future cash payments prevented the recognition of a restructuring gain under ASC 470-60-35-7 (see Section 11.5.2).

Connecting the Dots

Although interest payments that vary on the basis of a variable interest rate are similar to contingent payments in that their amount is uncertain at the time of the restructuring, they are accounted for differently from contingent payments (see Section 11.4.4.6).

11.4.4.5 Put, Call, or Prepayment Features

Sometimes, restructured debt includes put, call, or prepayment features. For example, as part of the restructuring of a debt instrument, a call option may be added to the debt or the terms of a previous call option may be amended. In determining whether to recognize a restructuring gain, the debtor generally analyzes a call, put, or prepayment feature that could accelerate the repayment of the restructured debt in a manner similar to how it analyzes a contingent payment term. That is, the debtor assumes that it will be required to make the maximum potential amount of principal and interest payments (e.g., the debt will be outstanding for the maximum number of periods possible).

A debtor should evaluate whether a put, call, or prepayment feature in a restructured debt instrument must be bifurcated under ASC 815-15. In performing this analysis, the debtor may be required to use significant judgment and consider the facts and circumstances. For example, assume that a debt instrument has a $10 million carrying amount, pays interest at 10 percent per year, and has a remaining term to maturity of five years. In a restructuring that is accounted for as a TDR, the principal amount of the debt is reduced from $10 million to $8 million, and the debtor obtains an option that allows it to repay the debt at any time for $8 million, plus accrued and unpaid interest. In this restructuring, no gain is recognized by the debtor because the total future undiscounted cash payments of $12 million (i.e., $8 million principal and five years of interest at $800,000 per year [i.e., $8 million × 10% × 5 = $4 million]) exceeds the carrying amount of $10 million as of the date of restructuring. Nevertheless, the call option added in the restructuring must be evaluated in accordance with ASC 815-15, under which it would be acceptable to view the debt instrument as having an initial recorded investment as of the date of restructuring of $8 million even though the carrying amount remains $10 million as of such date. If, instead of forgiving the principal amount by $2 million, the creditor reduced the annual interest payable from 10 percent to 5 percent, it would be acceptable for the debtor, in evaluating the call option under ASC 815-15, to calculate an initial recorded investment as of the date of restructuring on the basis of the net present value of total future cash flows after the restructuring. However, in all circumstances, the hybrid debt instrument (including any embedded feature) must be accounted for in accordance with the TDR guidance in ASC 470-60.

Because ASC 470-60 requires a debtor to assume that it will need to pay the maximum amount possible to prevent the recognition of a gain that may not be realized, contingent payments may be included in the carrying amount of a debt instrument after a TDR. In this situation, it may be acceptable for the debtor to assume that any contingent payments (other than embedded redemption features) that form part of the carrying amount after the application of TDR accounting do not have to be bifurcated under ASC 815-15 if such bifurcation would alter the TDR accounting. However, the debtor may need to bifurcate under ASC 815-15 any contingent payments that are not part of the carrying amount of the debt instrument after TDR accounting is applied.

11.4.4.6 Variable-Rate Debt

ASC 470-60

35-11 If amounts of future cash payments must be estimated to apply the provisions of paragraphs 470-60-35-5 through 35-7 because future interest payments are expected to fluctuate — for example, the restructured terms may specify the stated interest rate to be the prime interest rate increased by a specified amount or proportion — estimates of maximum total future payments shall be based on the interest rate in effect at the time of the restructuring. Fluctuations in the effective interest rate after the restructuring from changes in the prime rate or other causes shall be accounted for as changes in estimates in the periods in which the changes occur. However, the accounting for those fluctuations shall not result in recognizing a gain on restructuring that may be offset by future cash payments (see the preceding paragraph and paragraph 470-60-35-7). Rather, the carrying amount of the restructured payable shall remain unchanged, and future cash payments shall reduce the carrying amount until the time that any gain recognized cannot be offset by future cash payments.

If interest payments on restructured debt are variable (e.g., indexed to the prime rate or SOFR), the debtor must estimate the total amount of undiscounted future variable interest payments. To estimate that amount, the debtor uses the current variable interest rate in effect at the time of the restructuring (or the “TDR rate”). For example, if the restructured debt’s interest payments are indexed to the prime rate, the debtor estimates future interest payments on the basis of the assumption that the prime rate will not change in future periods.

The debtor determines whether it should recognize a restructuring gain at the time of the restructuring as follows:

If the carrying amount exceeds the total amount of estimated future undiscounted cash payments (including variable interest payments estimated at the TDR rate and the maximum possible amount of other contingently payable amounts), the debtor recognizes a restructuring gain and a corresponding adjustment to the carrying amount at the time of the restructuring. Unlike the accounting for other contingently payable amounts discussed in Section 11.4.4.4.1, a restructuring gain may be recognized at the time of the debt restructuring even if it is possible that it will be offset by future interest expense should actual payments exceed estimated payments because of an increase in variable interest rates.
If the total amount of estimated future undiscounted cash payments (including variable cash payments estimated at the TDR rate and the maximum possible amount of other contingently payable amounts) exceeds the debt’s carrying amount at the time of the restructuring, the debtor does not recognize a restructuring gain.

The debtor’s accounting for the variable-rate debt instrument after the TDR will depend on the particular facts and circumstances. Some matters to consider are as follows:

No gain is recognized on the TDR, and there are no contingently payable amounts — If the total amount of estimated future undiscounted cash payments (including variable interest payments estimated at the TDR rate) exceeds the debt’s carrying amount at the time of the restructuring (i.e., there was no restructuring gain), the debtor should recognize interest expense over the life of the restructured debt for the difference between the carrying amount and the total amount of undiscounted future principal and estimated interest payments. This will require the debtor to calculate a new effective interest rate on the restructured debt on the date of the restructuring. The effective interest rate on that date will reflect the rate that equates the present value of the future cash flows specified by the restructured terms (using the TDR rate as the variable interest rate) to the carrying amount of the debt on the restructuring date (which will be the same carrying amount as before the TDR since no gain was recognized). After the restructuring date, the debtor accounts for changes in the variable interest rate as a change in accounting estimate (see ASC 470-60-35-11) and amortizes any implicit premium that results from the restructuring. In other words, the restructured debt is subsequently accounted for in the same manner as any other variable-rate debt instrument that is issued at a premium. Therefore, the debtor will recognize interest expense in each subsequent financial reporting period at an amount equal to (1) interest at the then-current variable rate applicable to the financial reporting period less (2) the amortization of the implicit premium (if any) on the debt instrument that resulted from the restructuring. The debtor can apply either of the following methods discussed in ASC 320-10-35-18 to calculate the amortization of any implicit premium on the debt instrument that resulted from the restructuring:
- The variable rate in effect on the date of the restructuring — Under this approach, the amount of amortization in each financial reporting period is fixed as of the date of the TDR and does not change as the variable interest rate changes. This approach is illustrated in ASC 320-10-55-41.
- The variable rate as it changes over the life of the restructured debt — Under this approach, the amount of amortization in each financial reporting period depends on the variable interest rate, which is subject to change. In each period in which the variable interest rate changes, a new amortization rate is applied prospectively. This approach is illustrated in ASC 320-10-55-43.
The accounting discussed above is consistent with the guidance in ASC 470-60-35-7 provided that the combined effect of accounting for the change in variable interest rates as a change in accounting estimate and amortizing the implicit premium by using one of the above two methods does not result in the recognition of negative interest expense or a gain. For an illustration of this accounting, see Example 11-21.

Gain is recognized on the TDR, and there are no contingently payable amounts — If the total amount of estimated future undiscounted cash payments (including variable interest payments estimated at the TDR rate) is less than the debt’s carrying amount at the time of the restructuring, a restructuring gain is recognized and no future interest expense is recognized on the restructured debt provided that the TDR rate does not increase. However, because the variable interest rate will generally change after the date of the restructuring, the debtor will need to account for such changes. There are two acceptable methods of accounting for changes in the variable interest rate after the date of restructuring:
- Cumulative method — Under this approach, interest expense is recognized in a financial reporting period only if the cumulative amount of interest calculated in accordance with the variable rate specified in the terms of the restructured debt exceeds the cumulative amount of estimated interest calculated at the TDR rate. Otherwise, each variable interest payment calculated in accordance with the terms of restructured debt after the date of the restructuring is recognized as a reduction of the carrying amount of the restructured debt. In addition, under this approach, the debtor can reverse previously recognized interest expense to the extent that doing so is necessary to reflect cumulative interest expense (if any) that equals the actual amount of interest in accordance with the variable rate specified in the terms of the restructured debt less the estimated interest amounts calculated at the TDR rate. However, the reported carrying amount of the restructured debt on any financial reporting date cannot be less than the amortized balance of the restructured debt calculated in accordance with the TDR rate. This ensures that negative interest expense is not recognized and that a gain is not recognized before the maturity of the debt. For an illustration of this method, see Example 11-22.
- Period-by-period method — Under this approach, the debtor recognizes interest expense in each financial reporting period in which the variable rate specified in the terms of the restructured debt exceeds the TDR rate regardless of whether the TDR rate exceeded the variable rate specified in the terms of the restructured debt in a prior financial reporting period. The amount of interest expense recognized is equal to the principal amount of the restructured debt multiplied by the excess of the actual variable rate over the TDR rate. In periods in which the TDR rate exceeds the variable rate specified in the terms of the restructured debt, no interest expense is recognized, the carrying amount of the debt is reduced for the actual interest amount calculated at that variable rate, and the debtor is precluded from recognizing a gain or negative interest expense for any excess of the TDR rate over the variable rate. Any such gain would be recognized only on the maturity date of the debt instrument. For an illustration of this method, see Example 11-22.
Restructured debt includes contingently payable amounts — The accounting for restructured debt with contingently payable amounts will depend on the particular circumstances, including whether there was a gain recognized on the restructuring. In all situations, the debtor should expense any estimated losses under contingent payment terms that exceed the amount included in the carrying amount at the time of the restructuring (see Section 11.4.4.4.2).

In any instance in which the TDR rate exceeds the variable rate in a subsequent period (i.e., interest rates have decreased since the date of restructuring), ASC 470-60 precludes the debtor from recognizing a gain in earnings for the difference between actual and estimated payments before the debt’s extinguishment (see Section 9.2). The debtor recognizes any such gain only when no obligations remain (i.e., when the debt is extinguished).

Example 11-21

Accounting for a TDR — Interest Rate Changes From Fixed Rate to Variable Rate, and No Gain Is Recognized on Restructuring

Entity V has a fixed-rate loan with a principal amount of $325 million and a carrying amount of $333 million, which includes the principal amount plus $8 million of accrued interest. The stated interest rate on the loan is 12 percent per annum payable quarterly in arrears. The loan has a remaining term of five years.

Because of V’s financial difficulties, the lender agrees on June 1, 20X1, to restructure the loan as follows:

The $8 million of accrued interest is forgiven.
The interest rate is changed to the three-month U.S. Treasury rate payable quarterly in arrears.

On the date of restructuring, the three-month U.S. Treasury rate is 5.50 percent. There are no contingently payable amounts on the restructured loan. The principal amount of the loan is due in a single payment on the loan’s maturity date.

Entity V estimates the future principal and interest cash flows on the restructured debt by using the three-month U.S. Treasury rate on the date of the restructuring (the TDR rate) and calculates the total future cash flows on the restructured debt as follows:

On the basis of the loan’s carrying amount ($333,000,000) and the future cash flows of the restructured loan ($414,375,000), V determines that the effective interest rate on the restructured loan is 4.94 percent per annum. Because the principal amount of the original loan was equal to its carrying amount, the effective interest rate on the original loan was equal to its stated interest rate of 12 percent per annum. Since the effective interest rate of the modified loan is lower than that of the original loan, the lender has granted a concession. Because V is experiencing financial difficulties, the restructuring is a TDR.

Notwithstanding the TDR, in accordance with ASC 470-60, V does not recognize a restructuring gain because the carrying amount of the loan ($333,000,000) is less than the total amount of undiscounted future principal and interest cash payments specified by the new terms ($414,375,000).

After the date of the TDR, V will recognize interest expense on the restructured loan at 4.94 percent per annum if there are no changes in the three-month U.S. Treasury rate. As a result, the carrying amount of the restructured loan will equal the $325 million principal payment due on the loan’s maturity date. However, because three-month U.S. Treasury rates fluctuate, V will need to account for changes in the variable interest rate.

Entity V should recognize interest on the loan after the date of the restructuring at an amount equal to the applicable three-month U.S. Treasury rate less the amortization of the implicit $8 million premium in the carrying amount on the date of restructuring (i.e., $333 million carrying amount – $325 million principal amount).This premium must be amortized over the remaining five-year term of the loan in accordance with the interest method. Entity V can elect to use either of the following methods to amortize the premium:

The variable rate in effect on the date of the restructuring — Under this approach, the amount of amortization in each financial reporting period is fixed on the date of the restructuring and does not change as the three-month U.S. Treasury rate changes. The fixed amount of the premium amortization is 0.56 percent per annual period (i.e., 5.50 percent TDR rate – 4.94 percent effective rate calculated on the date of restructuring).
The variable rate as it changes over the life of the restructured debt — Under this approach, the amount of amortization in each financial reporting period will vary depending on the three-month U.S. Treasury rate. In each period in which the three-month U.S. Treasury rate changes, a new amortization rate is applied prospectively.

As a result of the recognition of the periodic interest on the restructured loan as described above, the carrying amount of the restructured loan will equal the principal amount due at maturity.

Example 11-22

Accounting for a TDR — Interest Rate Changes From Fixed Rate to Variable Rate, and a Gain Is Recognized on Restructuring

Entity W has a fixed-rate loan with a principal amount and carrying amount of $325 million. The stated interest rate on the loan is 12 percent per annum payable quarterly in arrears. The loan has a remaining term of five years.

Because of W’s financial difficulties, the lender agrees on January 1, 20X1, to restructure the loan as follows:

The $75 million in principal amount is forgiven.
The interest rate is changed to the three-month U.S. Treasury rate payable quarterly in arrears.

Entity W estimates the future principal and interest cash flows on the restructured debt by using the three-month U.S. Treasury rate on the date of the restructuring (the TDR rate) and calculates the total future cash flows on the restructured loan as follows:

On the basis of the loan’s carrying amount ($325,000,000) and the future cash flows of the restructured loan ($318,750,000), W determines that the effective interest rate on the restructured loan is negative. Because the principal amount of the original loan was equal to its carrying amount, the effective interest rate on the original loan was equal to its stated interest rate of 12 percent per annum. Since the effective interest rate of the modified loan is lower than that of the original loan, the lender has granted a concession. Because W is experiencing financial difficulties, the restructuring is a TDR.

In accordance with ASC 470-60, W recognizes a restructuring gain of $6,250,000 on the TDR, which equals the amount by which the carrying amount of the original loan ($325,000,000) exceeds the total amount of undiscounted future principal and interest cash payments specified by the new terms ($318,750,000). The journal entry recognized to reflect the restructuring gain is as follows:

After recognition of this restructuring gain, the carrying amount of the loan is equal to the total undiscounted principal and interest cash flows on the loan, calculated on the basis of the TDR rate. Therefore, if the three-month U.S. Treasury rate did not change during the remaining life of the loan, all payments made on the loan would be reflected as a reduction of the loan’s carrying amount and no interest expense would be recognized. However, since the three-month U.S. Treasury rate is expected to change during the remaining life of the loan, cumulatively, W will recognize either interest expense on the loan or a gain on extinguishment of the loan. Although the total income statement effect will be the same, the method that W uses to subsequently account for changes in the U.S. Treasury rate could affect the classification of the income statement amounts recognized during the remaining life of the loan.

As discussed above, there are two acceptable methods of accounting for changes in the variable interest rate after the date of restructuring: the cumulative method and the period-by-period method. The application of these two methods is discussed below and is based on the following assumptions regarding the three-month U.S. Treasury rate, which for simplicity purposes is shown only on an annual basis even though the variable interest is paid quarterly on the loan in arrears:

Cumulative Method

Under this approach, variable interest payments calculated in accordance with the terms of the restructured loan are recognized in each period as a reduction of the carrying amount of the restructured loan except to the extent that the cumulative variable interest payments exceed the cumulative estimated interest payments calculated at the TDR rate. Therefore, interest expense is recognized only if the interest rates have increased over the TDR rate on a cumulative basis, in which case such expense is recognized for the excess of the cumulative actual interest payments over the cumulative estimated interest payments calculated at the TDR rate. However, the reported carrying amount of the restructured loan on any financial reporting date cannot be less than the amortized balance of the restructured loan calculated in accordance with the TDR rate.

Using this approach, W would subsequently account for the loan after the restructuring date as follows:

Period-by-Period Method

Under this approach, variable interest payments after the date of restructuring are recognized as a reduction of the carrying amount of the restructured loan except to the extent that the variable interest rate in any financial reporting period exceeds the TDR rate. In any financial reporting period in which the variable interest rate exceeds the TDR rate, the debtor recognizes interest expense for the excess regardless of whether the TDR rate exceeded the variable rate in a prior financial reporting period. The amount of interest expense recognized is equal to the principal amount of the restructured debt multiplied by the excess of the variable rate specified in the terms of the restructured debt over the TDR rate. The debtor is precluded from recognizing a gain, or negative interest expense, in any financial reporting period in which the TDR rate exceeds the variable rate. A gain on extinguishment may only be recognized on the maturity date of the debt instrument.

Using this approach, W would subsequently account for the loan after the restructuring date as follows:

11.4.4.7 Comparison of ASC 470-50 and ASC 470-60

A debt modification or exchange that qualifies as a TDR should be accounted for as a modification of the debt terms under ASC 470-60 irrespective of whether the original and new terms are substantially different. This is unlike the analysis of a debt modification or exchange that does not qualify as a TDR under ASC 470-50, which should be accounted for as a debt modification or an extinguishment depending on whether the terms are substantially different (see Chapter 10). The table below depicts key differences between the accounting for a debt modification or exchange depending on whether the transaction qualifies as a TDR.

	TDR (ASC 470-60)		Not a TDR (ASC 470-50)
	Future Undiscounted Cash Flows Exceed Original Carrying Amount	Original Carrying Amount Exceeds Future Undiscounted Cash Flows
Terms substantially different	The carrying amount is reduced for restructuring fees paid to the creditor No restructuring gain is recognized Third-party restructuring costs are expensed The effective interest rate is adjusted prospectively on the basis of the adjusted carrying amount and the revised cash flows	The carrying amount is reduced to the amount of future undiscounted cash flows The difference between the undiscounted amount of future cash flows and the carrying amount is recognized as a restructuring gain Third-party restructuring costs reduce any gain No interest expense is recognized prospectively. Instead, subsequent interest payments reduce the debt’s carrying amount	The new debt is recognized at fair value An extinguishment gain or loss is recognized equal to the difference between the carrying amount of the original debt and the fair value of the modified debt instrument Restructuring fees paid to creditor are part of extinguishment gain or loss Third-party restructuring costs are treated as a debt issuance cost and amortized
Terms not substantially different	The carrying amount is reduced for restructuring fees paid to the creditor No restructuring gain is recognized Third-party restructuring costs are expensed The effective interest rate is adjusted prospectively on the basis of the adjusted carrying amount and the revised cash flows	The carrying amount is reduced to the amount of future undiscounted cash flows The difference between the undiscounted amount of future cash flows and the carrying amount is recognized as a restructuring gain Third-party restructuring costs reduce any gain No interest expense is recognized prospectively. Instead, subsequent interest payments reduce the debt’s carrying amount	The carrying amount is reduced for restructuring fees paid to the creditor No modification gain or loss is recognized Third-party restructuring costs are expensed The effective interest rate is adjusted prospectively on the basis of the adjusted carrying amount and the revised cash flows

The example below discusses a debt modification that qualifies as a TDR.

Example 11-23

Debtor’s Analysis of a Debt Modification That Qualifies as a TDR

Entity X issues debt on which it must make interest payments of $100 at the end of each year for five more years and repay the $1,000 face amount at the end of those five years. The stated interest rate is 10 percent, compounded annually. The debt’s initial and current carrying amount is $1,000, and the annual effective interest rate implicit in the debt is also 10 percent. If all contractual amounts are paid, the debtor’s total interest expense will be $500 — the difference between the total amount to be paid ($1,500) and the debt’s carrying amount ($1,000). The effective interest rate on the $1,000 carrying amount will be 10 percent.

Entity X and the creditor are considering whether to modify the debt in one of the following four ways:

Timing of interest only — Terms modified to defer payment of interest until the debt matures (a single collection of $500 at the end of five years is substituted for five annual collections at $100).
Amount of interest only — Terms modified to leave unchanged the timing of interest and the timing and amount of principal payment but to reduce the annual interest from $100 to $60.
Amount of principal only — Terms modified to leave unchanged the amounts and timing of interest but to reduce the principal amount to $800 due at the end of five years.
Both timing of interest and principal amount — Terms modified to defer collection of interest until the debt matures and to reduce the principal amount to $800 (modifications 1 and 3 combined).

The contractual cash payments before the modification and in the above four modification scenarios are as follows:

If X and the creditor modified the debt terms in accordance with one of the above four scenarios and the modification qualifies as a TDR under ASC 470-60, X would reduce the effective interest rate used to calculate interest expense on the debt prospectively in each of the four modification scenarios above in accordance with ASC 470-60-35-5 (see Section 11.4.4.2). The revised effective interest rate would be the discount rate that equates the future cash payments specified by the new terms with the debt’s carrying amount (see row (d) in the table below). Because the modified remaining cash payments would exceed the carrying amount, the carrying amount would not be adjusted, and there would be no restructuring gain in any scenario in accordance with ASC 470-60.

The following table illustrates the analysis under ASC 470-60 of each of these scenarios:

If the debt modification was not a TDR, the accounting analysis for the same set of facts would be different. Because the present value of the modified cash payments discounted at the original effective interest rate would be more than 10 percent different from the carrying amount (i.e., the present value of the original cash payments discounted at the original effective interest rate) in scenarios 2, 3, and 4, the original debt would be accounted for as an extinguishment under ASC 470-50 (see Section 10.4.2). Therefore, the new debt would be recognized at its fair value as of the modification date, an extinguishment gain or loss would be recognized for the difference between the carrying amount and the current fair value, and a new effective interest rate would be calculated on the basis of the initial carrying amount of the modified debt.

In scenario 1, the present value of the modified cash payments discounted at the original effective interest rate is less than 10 percent different from the carrying amount. Therefore, the debt would not qualify for extinguishment accounting under ASC 470-50 (see Section 10.4.3). Instead, X would calculate a revised effective interest rate in accordance with ASC 470-50-40-14 (see row (l) below). The table below illustrates the analysis under ASC 470-50 of each of the above modification scenarios in situations in which the modification does not qualify as a TDR. It is assumed in the scenarios that the applicable current market interest rate for the debt is 5.5 percent.

11.4.5 Accounting for a Combination of TDR Characteristics

ASC 470-60

35-8 A troubled debt restructuring may involve partial settlement of a payable by the debtor’s transferring assets or granting an equity interest (or both) to the creditor and modification of terms of the remaining payable. Even if the stated terms of the remaining payable, for example, the stated interest rate and the maturity date or dates, are not changed in connection with the transfer of assets or grant of an equity interest, the restructuring shall be accounted for as prescribed by this guidance. A debtor shall account for a troubled debt restructuring involving a partial settlement and a modification of terms as prescribed in paragraphs 470-60-35-5 through 35-7 except that, first, assets transferred or an equity interest granted in that partial settlement shall be measured as prescribed in paragraphs 470-60-35-2 and 470-60-35-4, respectively, and the carrying amount of the payable shall be reduced by the total fair value of those assets or equity interest. If cash is paid in a partial settlement of a payable in a troubled debt restructuring, the carrying amount of the payable shall be reduced by the amount of cash paid. A difference between the fair value and the carrying amount of assets transferred to the creditor shall be recognized as a gain or loss on transfer of assets. No gain on restructuring of payables shall be recognized unless the remaining carrying amount of the payable exceeds the total future cash payments (including amounts contingently payable) specified by the terms of the debt remaining unsettled after the restructuring. Future interest expense, if any, shall be determined according to the provisions of paragraphs 470-60-35-5 through 35-7.

Some TDRs involve a partial settlement of the debt through a transfer of cash or other assets or the issuance of equity instruments. The terms of the remaining debt might also be modified. When a TDR involves a combination of the characteristics in ASC 470-60-15-9(a)–(c), the accounting is as follows:

The debt’s carrying amount is reduced by the amount of any cash paid to the creditor.
The debtor recognizes a gain or loss on any noncash assets transferred that is equal to the difference between their carrying amount and fair value and reduces the debt’s carrying amount by that fair value.
The debtor recognizes the issuance of any equity instruments at fair value and reduces the carrying amount of the debt by that fair value.
Once the carrying amount has been reduced for the amount of cash and the fair value of any assets transferred or equity interests granted, the debtor applies the accounting requirements for troubled debt modifications and exchanges (see Section 11.4.4) to the remaining debt on the basis of the reduced carrying amount.

The guidance in ASC 470-60-35-8 applies to a TDR with a combination of the characteristics specified in ASC 470-60-15-9(a)–(c) even if such TDR does not involve a partial settlement of the debt (e.g., an asset transfer and debt modification that does not involve a reduction of the debt’s principal amount). Also, note that the fair value of the assets transferred or equity instruments issued may be different from any reduction in the debt’s carrying amount agreed to by the debtor and creditor.

Example 11-24

Accounting for a Modification Involving a Reduction of Interest Rate on a Payable in Exchange for an Issuance of Common Stock

Entity Y issues common stock to fixed-rate debt holders in exchange for delaying interest payments on the outstanding debt. The transaction qualifies as a TDR. Although none of the debt has been settled as a result of this transaction, this arrangement is analogous to a TDR with a combination of the characteristics described in ASC 470-60-15-6(a)–(c).

Entity Y should reduce the carrying amount of the debt by the fair value of the common stock issued, and it would not record a gain because the adjusted carrying amount of the debt does not exceed the total future cash payments required by the new terms (only the timing of the payments was affected). The reduction of the carrying amount effectively creates a discount on the debt, which will result in increased interest expense prospectively over the remaining term of the debt, as described in ASC 470-60-35-5 through 35-7.

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